Ambuja Cements (ABUJ.BO) Sell: An Expensive Stock Citi

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Ambuja Cements (ABUJ.BO)
Sell: An Expensive Stock
 TP hiked to Rs117, maintain Sell — We raise our TP to Rs117 (from Rs108)
based on Sep12 EV/tonne of US$120 (vs. Dec11 earlier). At our revised TP,
Ambuja trades at an EV/EBITDA of 7.0x and a P/E of 15.2x for Sep12. At its
current price, the stock trades at Sep12 EV/tonne of US$156, 9.1x EV/EBITDA
and 19.1x P/E. Maintain Sell on relatively expensive valuations, expected price
correction due to massive capacity creation, and cost pressures.
 Estimates changed — We raise our PAT estimate by 8% for CY11, but leave it
largely unchanged for CY12. Ambuja’s volumes have come in lower than
expectations and we cut CY11-12 sales volumes each by 6%. However, average
selling prices have been firmer than anticipated & we now expect average prices
to be 9-10% higher than in our previous estimates. We expect average domestic
prices to rise 9% yoy in CY11E (earlier -6%) & 1% in CY12E (earlier -6%).
 Update on expansion plans — Ambuja’s capacity was raised to 25m tpa as of
end-CY10 as it commissioned the following capacities during CY10: 2.2mtpa
clinker units each in Chhattisgarh and Himachal Pradesh; 1.5mtpa cement
grinding capacity each in Uttar Pradesh and Himachal Pradesh. Capacity has
been further raised to 27m tpa in mid-CY11 with the commissioning of 1mtpa
cement grinding capacity each in Chhattisgarh and Maharashtra. Ambuja is going
ahead with plans to set up 2.2mtpa clinker capacity in Rajasthan. Ambuja has
~410MW of captive power which helps meet ~80% of its power needs.
 Key developments — 1) Ambuja has invested in a JV for captive coal mining,
which will take 2-3 years for commissioning; 2) In 2Q CY11, Ambuja acquired an
85% stake in Dang Cement Nepal for Rs191m; 3) In Jul11, Ambuja spent
Rs100m to acquire 50% in a JV, Counto Microfine Products; 4) Rs165m spent on
acquiring 60% stake in Dirk India, a fly ash processor.
 Stock is expensive — Cement prices fell during April to July11, but have
recovered most of the lost ground since July as volumes have been reportedly
cut to help hike prices. Prices have been hiked by 9-27% since July and (in all
markets except the south where Ambuja has a negligible presence) prices are
likely to remain firm near term. However, we maintain Sell on Ambuja as we
expect a price correction due to the existing oversupply and as it is relatively
expensive at an EV/t of US$156/t.
 Upside risks — (1) Continued price strength, (2) Delays in capacity and (3)
higher-than-expected demand growth.
Ambuja Cements
Company description
Ambuja Cements (ACL) is one of India's lowest-cost cement producers with
relatively much higher EBITDA margins due to its focus on the retail cement market
(giving higher realizations), modern plants with low power and fuel consumption,
and use of sea transport. In recent times its EBITDA margins and EBITDA/tonne are
only slightly higher or in line with its peers due to their continuing focus on reducing
costs and Ambuja’s reliance on imported coal (~30% of its requirements). Its
capacity is currently 27m tpa and it is going ahead with plans to set up 2.2mtpa of
clinker capacity in Rajasthan. Its largest markets are North India (40% of sales
volumes) and West India (40%). East India accounts for 20% of its volumes. Holcim
holds around 50% in ACL. Adding on the capacity of ACC gave the Holcim Group a
total capacity of 57m tpa in India and a significant presence in several key markets.
Investment strategy
We rate ACL Sell/Low Risk (3L) with a target price of Rs117. This is based on
expected pricing pressures due to the current industry oversupply and as the stock
looks relatively expensive at an EV/t of US$156/t. Prices have recovered lost
ground by 9-27% since Jul11 largely on the back of production cutbacks and
despite sluggish demand trends. We expect EBITDA margins to decline yoy during
CY11-13 largely due to sluggish price trends. ACL benefits from its captive power
capacity of ~410MW which meets 80% of its power requirements. We expect
domestic cement prices to rise 8.5% in CY11, and 1% in CY12 and 2% in CY13. We
expect volumes to grow 4% in CY11, 9% in CY12 and 8% in CY13. Maintain Sell on
relatively expensive valuations, expected price correction, and cost pressures.
Valuation
We use EV/tonne to value ACL, a common metric used to value cement companies.
We set our target price at Rs117, in line with current trends in replacement cost of
US$120/t. We value ACL in line with replacement costs (as against a discount used
earlier) as long term demand growth is expected to be robust and new capacity
creation is slowing down. Our target price of Rs117 equates to a Sep12 EV/EBITDA
valuation of 7.0x and a PE of 15.2x.
Risks
We rate ACL Low Risk, in line with our quantitative risk-rating system, which tracks
260-day historical share price volatility. We think this is appropriate based on its
relatively healthy balance sheet (it has a net cash position) and focus on cost
cutting. Key upside risks to our target price include: (1) Continued price strength; (2)
Delays in industry capacity; and (3) Better-than-expected domestic demand growth.